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What is a Merchant Cash Advance and How Can It Help Small and Medium Businesses?

Learn the ins and outs of merchant cash advances and how they can help small and medium-sized businesses better manage cash flow and grow.

Finance your BusinessFinancing

By Pipe 15 Min Read — April 2, 2024

Business owners frequently find themselves in need of fast and accessible financing. Whether it's restocking inventory, launching a marketing campaign, or investing in cost-saving equipment, it’s often essential to access capital outside of your regular cash flow.

However, getting funds through traditional means like bank loans can be a slow and challenging process. This is where a merchant cash advance comes to the rescue. Think of it as a fast way to refuel your business without the long waits that often come with traditional small business loans.

In this article, we'll dive into what a merchant cash advance is, its benefits for businesses, how it compares to traditional loans, and how to decide if it's the right choice for your business. Let's get started!

Understanding the basics of a merchant cash advance

A merchant cash advance is a financial arrangement that provides businesses with a lump sum payment in exchange for a predetermined percentage of their future sales.

Unlike traditional loans, payments on an MCA are flexible and directly tied to daily sales, making them suitable for businesses with fluctuating revenue. This alternative funding option is designed to offer quick and flexible access to capital, particularly for businesses that may face challenges qualifying for traditional bank loans.

Here's a breakdown of how a merchant cash advance works:

  • Application and evaluation: When a business applies for a merchant cash advance, the funder reviews its credit and debit card transaction history to assess its eligibility and determine the amount of funding it qualifies for. This evaluation helps the funder gauge the business's capacity to generate future sales and pay back the advance.

  • Funding: Once approved, the funder disburses a lump sum payment to the business, typically deposited into its bank account within a few business days. This swift access to funds empowers businesses to handle pressing financial needs, whether it's acquiring inventory, expanding operations, or covering unforeseen expenses.

  • Payment structure: Unlike traditional loans with fixed monthly payments, a merchant cash advance is paid back through a percentage of the business's daily credit card or debit card sales. The payment amount fluctuates based on the business's daily sales. This means that on days when the business has lower sales, they’ll pay less toward their advance, and vice-versa.

  • Automated payment: The payment process is often automated, with the funder deducting the agreed-upon percentage from the business's daily sales (or, in some cases, weekly).

This continues until the advance and any associated fees are fully repaid. Usually, this lasts anywhere from 3 to 18 months. This flexibility can be particularly beneficial for businesses with fluctuating sales volumes, as their payments will align with their revenue stream.

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How do funders determine MCA rates?

Funders determine rates for merchant cash advances (MCAs) based on various factors, and the process can vary from one funder to another. Here's a simplified overview of how funders might determine their rates:

  • Business risk assessment: Funders assess the risk associated with the business seeking an MCA. This risk evaluation may consider factors such as the business's credit history, financial stability, industry, and time in operation. The riskier the business appears, the higher the rate may be to compensate for the increased risk.

  • Expected credit card sales: Funders often base rates on the business's daily credit card sales or daily bank deposits. The more consistent and substantial these sales are, the lower the risk for the funder. Businesses with stable daily sales may receive lower rates.

  • Competitive factors: Market competition plays a role in determining rates. Funders may adjust their rates based on what competitors are offering to attract businesses, especially in a highly competitive market.

  • Business performance: Some funders may assess the financial performance of the business by reviewing bank statements, credit card processing history, and cash flow. A strong financial performance could lead to a lower rate.

  • Amount and use of funds: The purpose of the MCA funds may influence the rate. If the funds are for a high-return investment in the business, a funder might offer a more favorable rate.

The size of the advance can also affect rates. Larger advances may come with lower rates because they generate more revenue for the funder.

  • Individual funder policies: Each MCA provider has its own underwriting and pricing policies. This can result in varying rates from one funder to another.

The rate is typically expressed as a decimal or percentage, and it represents the total amount to be paid back. To understand the cost of an MCA, multiply the factor rate by the advance amount. For example, if you receive a $50,000 MCA with a factor rate of 1.3, you'll pay a total of $65,000.

The benefits of a merchant cash advance for your business

A merchant cash advance provides several distinct advantages for businesses, particularly when compared to traditional bank loans.

1.  Immediate access to capital

One of the primary advantages of a merchant cash advance is the speed at which businesses can access the funds they need.

MCA funders understand the urgency of business needs, and they often deliver funds in a remarkably short time frame. Think hours or days, not weeks or months. Traditional bank loans, on the other hand, often involve a lengthy and cumbersome application process, with paperwork, credit checks, and extensive reviews that can drag on for ages.

In contrast, applying for a merchant cash advance is relatively quick and straightforward, with many funders offering online application processes.

With MCA's quick access to capital, businesses can take advantage of growth opportunities as they arise.  If you own a retail business, for instance, and you suddenly experience a surge in demand for your products, your business can quickly acquire additional inventory to meet the increased demand, ensuring that you don’t miss out on potential sales.

Moreover, immediate access to capital can also help businesses navigate unexpected expenses or emergencies.  Life in business is full of surprises, and not all of them are pleasant. When unexpected expenses crop up, an MCA can be a lifesaver.

Whether it's repairing a crucial piece of equipment or covering unexpected bills, having quick access to funds can prevent disruptions to daily operations and maintain business continuity.

2. Flexible payment terms

Another significant benefit of opting for a Merchant Cash Advance is the flexibility it brings to the table when it comes to payment. Instead of locking you into a set monthly amount, MCA connects payments to a percentage of your daily sales. 

This setup allows businesses to navigate periods of lower revenue without the added burden of fixed monthly installments, helping them effectively manage their cash flow. 

This flexibility is invaluable, especially during challenging times like seasonal downturns or economic uncertainties. In such situations, businesses may experience temporary declines in sales. Flexible payment provides breathing room and allows companies to rebound without the heavy weight of inflexible payment schedules.

The adaptable payment terms also cater to businesses with fluctuating revenue patterns. For those facing peaks and valleys in their sales, a merchant cash advance provides access to capital without worrying about a fixed payment schedule putting a pinch on their cash flow.

3. No collateral required

Again, most traditional banks require you to provide collateral, such as real estate or valuable assets, as security for traditional loans. Of course, this bar often poses a significant barrier for businesses that lack substantial assets to pledge.

Unlike many other forms of capital, a merchant cash advance is typically unsecured. This means that it eliminates the need for businesses to provide collateral, because the capital is funded based on your ability to pay the advance, and not on your assets. 

The absence of collateral makes it a viable funding option for a broader range of businesses, particularly startups and small businesses that might not possess the necessary assets to secure a traditional loan. 

4. Use of funds

Merchant cash advances typically don’t come with restrictions on how businesses can use the funds, so long as they’re used for business purposes. This flexibility allows businesses to allocate the capital where it's needed most, whether for inventory replenishment, marketing initiatives, equipment upgrades, expansion plans, or any other operational requirements. This freedom in fund utilization supports businesses in pursuing their specific growth strategies.

5. High approval rates

Merchant cash advances often have higher approval rates compared to traditional loans. The evaluation process often focuses on a business's daily credit card sales and less on credit history, making it a viable option for businesses with less-than-perfect credit or shorter operating histories.

Comparing merchant cash advances with traditional business loans

Merchant cash advances and traditional business loans are two distinct financing options available to businesses. Each has its own characteristics, advantages, and drawbacks. Here's a comparative analysis to help you make an informed choice between the two:

1. Structure and payment

  • Merchant cash advance: With an MCA, you're not taking a loan but getting an advance based on your future credit card sales or daily bank deposits. You pay it back by having a fixed percentage taken from your daily sales until the advance, plus fees, is fully paid back. This means that the amount you pay fluctuates with your sales volume.

  • Traditional business loans: Traditional loans have fixed monthly payments. You agree to specific terms and interest rates when you borrow the money, and you pay the same amount every month, regardless of how your business is doing sales-wise.

2. Approval process

  • Merchant cash advance: Merchant cash advances often have a quicker approval process with less stringent credit requirements. Providers are more interested in your daily credit card sales or bank deposits, making it accessible for businesses with weaker credit profiles.

  • Traditional business loan: Traditional loans involve a more rigorous approval process, including a thorough credit check, financial statements, and collateral in some cases. This makes them more challenging to secure, especially for new or small businesses with limited credit history.

3. Cost of financing

  • Merchant cash advance: MCAs come with a fee rather than an interest rate. This can make MCAs more expensive than traditional loans, depending on how quickly they’re paid back. The issue arises if your revenue is higher than anticipated, shortening your payback period and increasing your monthly cost of capital. 

  • Traditional business loans:  Traditional loans may have lower interest rates, making them more cost-effective in terms of total payment, but come with a major risk to your cash flow if you have a down month or slow season when servicing the loan payments is difficult.

4. Flexibility

  • Merchant cash advance: Merchant cash advances offer flexible payback, as they are linked to daily sales. This means that when sales are low, payments decrease. However, it also means you pay more when sales are high.

  • Traditional business loans: Traditional loans have fixed monthly payments, making them more predictable. However, this lack of flexibility can be challenging for businesses with fluctuating revenue.

5. Use of funds

  • Merchant cash advance: MCAs are often used for everyday expenses, like covering cash flow gaps or working capital. They may not be ideal for long-term investments or large capital expenditures.

  • Traditional business loans: Traditional loans can be used for a wide range of purposes, although they often come with restrictive covenants that specify how you can use the funds. They can be a better fit for large capital expenditures, especially in equipment or property that can serve as collateral.

6. Risk

  • Merchant cash advance: The risk with a merchant cash advance is tied to daily sales. Months with high sales can lead to higher payments. 

  • Traditional business loans: Traditional loans carry a more standard and predictable risk profile with set monthly payments. If you miss payments, it can negatively impact your credit.

7. Collateral

  • Merchant cash advance: MCAs are usually unsecured, meaning they don't need collateral. Instead, your future sales act as a sort of guarantee.

  • Traditional business loan: Traditional loans can be secured (require collateral) or unsecured (don't need collateral). It depends on the loan type and lender.

Is a Merchant Cash Advance Right for Your Business? You may be tempted to ask which financing method works best.

As you may have noticed, there’s no one-size-fits-all answer. When deciding between an MCA and a traditional loan, think about your business's specific needs, financial situation, and long-term goals.

Should you get a merchant cash advance for your business?

Now that you know about merchant cash advances and their benefits, it's important to decide if it's the right financing choice for your business. Here are two main things to think about:

  • Your business's financial needs: First, consider what your business needs the money for. Is it for buying inventory, getting new equipment, starting marketing campaigns, or other things to help your business grow? Knowing exactly why you need the funds will help you figure out how much you should ask for.

  • Your ability to pay: Merchant cash advances get paid back using a part of your daily sales. If your revenue varies from day to day or month to month, this structure may be a better fit than a fixed payment schedule common in traditional loans.

By thinking carefully about these two factors, you can make an informed decision about whether a merchant cash advance is the right fit for your business.

Find out if Pipe is right for you

Typical merchant cash advances come with all the pros and cons we’ve just talked about. A revenue advance from Pipe is one of the most merchant-friendly options for accessing capital quickly and easily. Pipe advances are based purely on the health of the business, measured in real time with secure live data connections. This allows business owners to access the capital they deserve while staying focused on running the business, not on lengthy applications. 

You pay back your advance with a portion of daily revenue, so payments flex with your cash flow. 

To find out if Pipe’s fast, frictionless capital is right for you, you can learn more and sign up in minutes.

Disclaimer: Pipe and its affiliates don't provide financial, tax, legal, or accounting advice. What you're reading has been prepared for knowledge-sharing and informational purposes only. Please consult your financial and legal advisors to determine what transactions and decisions are right for you and your business.

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Pipe Pipe is the modern capital platform built to connect entrepreneurs and business owners to fast, frictionless, dilution-free financing. Pipe turns all forms of revenue into up-front working capital to help companies improve cash flow, scale operations, and grow on their terms.

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